There has recently been publicity about IRS clarification of the differences between
tips and service charges. Several articles indicate that prior IRS guidance was
ambiguous. See http://www.irs.gov/irb/2012-26_IRB/ar07.html for the new IRS
rule (Internal Revenue Bulletin 2012-26,
June 25, 2012).

The DOL position concerning service charges, for Fair Labor Standards Act (FLSA)
purposes, has been clear for more than four decades. Other than the IRS citation
above, this article is limited to the FLSA.

The title is redundant for a reason – to include all three related terms. Tips and
gratuities are actually interchangeable terms. However, some employers have a
tendency to inaccurately refer to a service charge as a “gratuity.” This can
result in record keeping and overtime violations.

Employers often misunderstand the differences between tips and service charges. A good
grasp of these differences will enable an employer to achieve and maintain
compliance with FLSA record keeping, minimum wage, and overtime compensation
provisions.

While the DOL position regarding service charges has been clear over the years, tips
are another matter. DOL guidance and enforcement policies (regarding tips) have
varied because of statutory changes, ambiguity of the FLSA provisions, and (prior
to April 5, 2011) obsolescence of regulations.

The hospitality industry dominates when there are concerns about tips and service
charges, but many other types of business are also affected.

Tip and service charge comparisons, and FLSA considerations:

A tip or gratuity is given voluntarily by the customer. A charge added to the ticket
(usually a percentage) based on the establishment’s policy is generally viewed
by DOL as a service charge.

A tipped employee may be paid wages of less than the minimum wage (but no less than
$2.13 per hour), if tips received and retained bring the employee’s wage rate
up to the minimum wage. This computation is done on a workweek basis. If tips
are insufficient, supplemental pay is required.

During my DOL career, I asserted back wage liabilities on numerous occasions when
employers had failed to compute proper overtime compensation for tipped and/or
service charge employees. As an FLSA consultant, I have assisted clients who
were making these types of mistakes. An employer will find it easier to
understand the overtime concepts when tips and/or service charges are involved
if the overtime wages are viewed as additional half-time pay (not as
“straight-time plus time and one-half”). The result, of course, must be time and one-half. All of the wages, for all of the hours
worked, are initially determined (on the basis of a workweek). This is the regular pay. Total regular pay divided
by total hours worked equals the regular rate. This is the average hourly rate, for the workweek, that is being paid
for all of the hours of work. The regular rate is never less than the minimum wage; it is likely to exceed the
minimum wage if service charges are involved or if an employee has worked
non-tipped hours at a rate higher than the minimum wage. One-half of the
regular rate times the overtime hours equals premium overtime pay for the
workweek. A review of the record keeping regulations, previously linked, is
helpful in this regard. Also see http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr;sid=ad743bd49d828e6ffa1f97829ae7b77c;rgn=div5;view=text;node=29%3A3.1.1.2.39;idno=29;cc=ecfr.

If a tipped employee is paid a cash rate of the full
minimum wage, or greater, the rate paid is the regular rate (unless there are
supplements that increase the rate, such as commissions, bonuses, or service
charges). True tips do not increase the regular rate.

If a tipped employee is paid a cash rate (not less
than $2.13 per hour) of less than the full minimum wage, the regular rate is
the minimum wage. In such a case, the additional half-time compensation owed
for overtime hours is .5 times the minimum wage (not one-half of $2.13).

If there are some hours worked during the workweek in a non-tipped occupation, at least the
minimum wage must be paid for each of those hours (no tip credit). If such
hours are paid at a rate in excess of the minimum wage, the weighted average
rate for the workweek will be greater than the minimum wage.

If there are some hours worked during the workweek in a non-tipped occupation, at least the minimum wage must be paid for each of those hours (no tip credit). If such hours are paid at a rate in excess of the minimum wage, the weighted average rate for the workweek will be greater than the minimum wage.

The Wage & Hour Self-Audit Guide, in the Self Auditing area of www.BizKeys.com, contains a minimum wage section that briefly discusses tips, and
an overtime compensation section that covers the overtime basics.